California Choppers Case

The California Chopper’s financial position is in fairly good standing. Although, there are some concerns in certain areas, which will be discussed below. Attached to the memo is an excel spreadsheet that can be used for referencing.
Liquidity
California Choppers (CC) appears to be acceptable in terms of their liquidity. Their current ratio seems to be right around the industry average for the past five years. On the other hand, the cash ratio could improve a little bit. Although the cash ratio numbers are similar to the industry average, companies want to see this number improve. By looking at the attached selected ratios spreadsheet, it can be seen that from year 2004 to year 2005, the cash ratio dropped significantly.

This could be due to the inconsistent credit terms for both CC’s customers and also for themselves. When looking back at the balance sheet, the amounts of account receivables and account payables increased significantly from year 2000 to year 2005, which could mean that credit terms are not being paid within reasonable time.
Asset Management
Asset Management can be looked at through various directions.
•First, asset management can be looked at through inventory. CC’s inventory was very unpredictable throughout the years 2000-2005. The inventory levels went from a low of $17.12 million in 2000 to a high of $82.69 million in 2002. In the year 2001 the inventory turnover was 2.64 and then in 2001 the inventory turnover was 6.13. Two assumptions can be possibly made, one that there were a lot of sales made, the other that there is ineffective buying. Considering that sales have increased throughout the years, we can assume that this is due to strong sales. Also, the inventory turnover in days was very high compared to the industry average in 2001, which makes sense because the sales were so low in that year compared to now.
•Next, we can look at the account receivable turnover to look further into asset management. For the most part, the account receivables turnover in days was above the industry average. On the other hand, that turnover in days was lowering throughout the years or just staying right around the same number. This could indicate that the credit sales are taking longer to collect.
•Then, asset management can be looked at through account payables turnover. The account payables turnover in days was significantly higher than the industry average. There also was a trend which showed that the account payables turnover in days decreased throughout the years, except in the year 2005. Noticing that the turnover ratio in days was falling, could indicate that it is taking CC longer to pay off their suppliers.
•Next, we can look at the cash conversion cycle. The cash conversion cycle stands out due to the fact that the ratio is not very close to the industry average. The ratio actually even becomes negative in the years 2004 and 2005. This is not a huge concern, but it is just showing that the account payable turnover in days is larger than the account receivable turnover in days and the inventory turnover in days. As stated above, this is due to the fact that CC is taking longer to pay their suppliers. Very similar to the cash conversion cycle, is the operating cycle. The operating cycle decreased throughout the years, which is not a major concern.
•Lastly, as far as it goes for the fixed asset turnover and the total asset turnover, both number are similar to the industry average throughout the last 5 years. Therefore, nothing to worry about for those two ratios. Long-Term Debt Paying Ability
There are four ratios to consider when looking into the long term debt paying ability. The first ratio is the debt to asset ratio and the numbers are just slightly over the industry average, therefore this must mean that most of CC’s assets are financed through debt. In addition, the debt to equity ratio is very high in 2001 and then gradually declines throughout the next four years. This is no surprise due to the major expansion that CC took on in 2001. Lastly, the long term debt to capitalization ratio slowly decreases which is just showing how CC is not being risky with their capital through debt.
Next, looking at the times interest earned, it is very obvious that the numbers are very low compared to the industry average, which is not favorable. A lower times interest earned ratio could indicate that CC may or may not be able to repay their interest and debt. It is not saying that CC will not be able to pay its debt but it could be a sign.
Profitability
The gross profit margin for CC is right around the industry average. Although the numbers seems to be decent, the costs of goods sold are too high. Next, looking at the operating profit margin, the numbers don’t look as great as they should. The numbers are low compared to the industry average in years 2001, 2004, and 2005. This may indicate that CC should look into their prices and costs. In 2001 the net profit margin was very low compared to the industry average. I am assuming this is due to the major expansion. It is also important to look more deeply into the numbers though because the net profit margin is lower compared to the industry average in all of the years. Once again CC should look into their costs and how efficient they are converting sales into actual profit.
The operating income return on investment fluctuates throughout the years, this can be normal but it may also have a downside. Next, CC’s return on assets ratio is much lower compared to the industry average. Once again, in 2001 this is normal due to the major expansion but the next years should have increased more than they did. Lastly, the return on equity fluctuates a lot but for two years the numbers are over the industry average, which was good. Now the last couple of years, the numbers have decreased which in return shows how CC has not been efficient in utilizing their equity base.
Recommendations
First, when looking at liquidity, the loans that CC undertook had requirements and one was to make sure that the current ratio stays at 1.25. In year 2005 the current ratio dropped to 1.04, so be aware of current assets and current liabilities to make sure the ratio stays at 1.25. Also, CC should focus on improving their credit terms. For instance, maybe offer a 2% discount if the invoice is paid within 10 days.
This could force customers to pay on time and also then CC will have the cash flows needed to pay their suppliers on time. Once again, the credit policies and collection procedures are a concern for the asset management section. CC needs to improve this in order to have a lower account payable turnover, a lower account receivable turnover, and a lower inventory turnover. CC has been trying to focus on lowering overhead costs and also focusing on debt reduction. I would suggest to keep going further with these reductions. CC needs to be concerned with looking into their prices and maybe slightly raising them.
On the other hand, CC needs to be aware of their costs, especially costs of goods sold. Becoming aware of prices and costs could increase the gross profit. I noticed that another requirement for the loans that CC took out was to make sure that the times interest earned was at 2.0. I thought that CC did a good job of keeping that number above 2.0. Although, something to consider is when CC takes on a new product development, they should consider borrowing at a lower cost of capital than what they are currently paying in order to meet debt obligations. In conclusion, I thought overall that CC is in fairly good standing, although they should be aware of key ratios that could help them improve as a company. If you have any questions or concerns, feel free to contact me.